Low margins, high taxes will drive health plan consolidations

December 1, 2010

Plans will look to mergers and acquisitions to reduce administrative costs and meet medical loss ratio requirements

NATIONAL REPORTS-Over the next few years, it's likely health plans will look to mergers and acquisitions to reduce administrative costs and meet minimum medical loss ratio requirements.

According to a recent report from Deloitte, the Patient Protection and Affordable Care Act (PPACA) is likely to significantly increase M&A activity for U.S. health plans and healthcare providers. The report recommends organizations strategically evaluate the risks to complete an effective deal in the complex, post-reform environment.

Brian Flanigan, a principal with Deloitte's M&A Consulting Services, says smaller plans are looking for a larger partner with a bigger balance sheet, broader business capabilities and sophisticated data systems. National plans also will continue to diversify revenue streams, as was the case with UnitedHealth Group's acquisition of Executive Health Resources Inc., a Pennsylvania-based medical services firm, earlier this year.

But he predicts M&A activity likely won't ramp up immediately because so much of the PPACA is contingent on forthcoming legislative interpretation. That guidance will have a significant impact on how the industry responds.

Carl Mercurio, president of New York-based Corporate Research Group, a division of WRG Research Inc., similarly anticipates a considerable amount consolidation coming down the road.

"The average profit margin is 3% to 5%-higher for for-profit plans," Mercurio says. "The margins are small, and now they're going to get hit with taxes and the requirements of the minimum medical cost ratios, and all of that will cut into margins further."

The only way to make the financial numbers work is to spread the overhead and administrative costs over a larger revenue and membership base. Smaller plans are ripe for acquisition. Remaining not-for-profit Blues plans might convert to for-profit status.

"The health plan space-despite the fact you still have very large players-is still very much disaggregated," says Phil Pfrang, partner with Deloitte & Touche's M&A Transaction Services. "It's going to be harder to be a managed care company in the wake of reform."

INSURERS' LONG TAIL

The top 10 health plans, which average about 12 million lives, only represent 22% of the total market and hold about half of their membership in traditional or insured markets with the rest in administrative services contracts.

"When you start going down the scale and getting into smaller managed care organizations, [fully insured] percentages track upward, so they are more heavily depending on insured products and are less diversified, in terms of what business services they offer," Pfrang says. "Those companies are not as well positioned to deal with the stress of regulation."

Health plans may look to acquire technology companies and population management businesses.

Another outlet for future alignment may be investments in provider-oriented organizations, such as accountable care organizations (ACOs). Flanigan says ACOs could provide an impetus for health plans and providers to align incentives in a way they haven't done before.

Deloitte's hypothesis is that the industry structure will evolve over the next five to 10 years, and acquisitions will have a role in that.

"Kaiser is a health plan and a provider," Pfrang says. "Is that a model that we're going to see into the future and will that help shape the industry structure, or are we going to see more and different partnerships between plans and providers, either through mergers or joint ventures?"

As markets consolidate and consumers are left with fewer choices, some are raising concerns.

The American Medical Assn. (AMA) calls the impending mergers and acquisitions a "near total collapse" of competition. In a recent report, the AMA indicated the lack of dynamic insurance markets actually hurts consumers through increased insurance premiums, deductibles and copayments.

Flanigan says there is still uncertainty over how anti-trust concerns will be handled once consolidation activity picks up.

"To the extent that an insurance company is in a point of financial distress, regulators don't have a lot of different instruments to fix that problem," Flanigan says.

Once triggers occur that cause involvement of regulators, the question becomes whether to let a plan become insolvent or to find an acceptable transition.